Rare Software Stock Paying 7% Dividend

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by Marc Lichtenfeld

Magic Software Enterprises (Nasdaq: MGIC) is the rare software company that has a big yield. Most tech companies don’t pay dividends at all – and of the ones that do, very few have yields above 3%. Magic Software’s current $0.327 per share semiannual dividend comes out to a yield of 6.7%.

But can the Israeli company keep it up?

Over the last four quarters for which we have data (the company has not yet released its fourth quarter results), Magic Software generated $80 million in free cash flow. It paid $30.8 million in dividends over that span for a nice low payout ratio of 39%.

That means the company is paying out just $0.39 in dividends for every dollar in free cash flow, so it can comfortably afford its dividend. (Remember, I use free cash flow rather than earnings to calculate a company’s payout ratio because it’s easier for management to manipulate earnings numbers.)

Magic Software is a small cap stock with a market cap under $500 million. As a result, only two sell-side analysts cover the stock, and they have not published free cash flow estimates for 2024. So we’ll have to make our own assumptions.

Earnings are projected to be flat this year, while revenue is forecast to decline by 10%. Since earnings are expected to be flat and management has not provided any guidance so far, we’ll assume that free cash flow will also be flat.

The company has reduced its dividend a few times in recent years. In 2022, the dividend dipped from $0.234 to $0.216 per share, and in 2020, it was nearly cut in half from $0.156 to $0.08 per share.

All in all, there have been seven cuts in the past 10 years, with the others coming in 2014, 2015, 2016 and 2019. So while the overall trend has been higher, there have been periods when the dividend was reduced for a short time.

The company can easily afford its dividend based on the trailing 12 months numbers, but it has shown a willingness to cut the dividend on a fairly regular basis.

Even if Magic Software sustains its dividend in the near term, I wouldn’t get too comfortable with it.

Dividend Safety Rating: D

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